An active management approach to the flattening of the yield curve



TThe Fed is due to meet on Wednesday of this week to discuss plans to reduce and speed up the initial deadline from June to potentially March. The meeting follows the November CPI report on inflation continuing to rise and bond markets giving warning signs of an impending economic pullback via the yield curve, reports the Financial Times.

So what exactly is the yield curve, and why is it important? The yield curve in a developed country is primarily a reflection of investor confidence in the performance of the economy going forward. It is a measure of the interest rate that buyers of government securities want on their various term loans, whether short or long term.

Short-term yields are generally a barometer of investor sentiment towards central bank policies in the immediate future, while longer-term yields are generally a measure of the direction investors are taking in the intermediate to distant future. regarding growth, inflation, and interest rates.

“People are excited about the yield curve because historically it has been a good predictor of the onset of a recession,” said Richard McGuire, fixed income strategist at Rabobank.

In times of growth and a positive outlook for investors, the yield curve is steeper as strong economic growth can eventually create inflation as demand begins to outstrip supply, and central banks should raise rates. in response.

During an economic downturn, the yield curve flattens and may even reverse, signaling an economic recession. Yields on 10- and 30-year bonds are falling towards shorter-dated bonds, with investors betting on lower interest rates and minimal intervention due to the absence of inflationary pressures.

How the pandemic impacted the yield curve

Towards the end of 2019, the yield curve had inverted, signaling an impending recession, then the pandemic struck, sending the economy into a spiral regardless. The yield curve rose sharply in 2021 due to the economic recovery and the Fed’s wording that pointed to continued low interest rates, allowing inflationary pressures to intensify and leading to potential more rate hikes. high across the board.

Image source: The Financial Times

The pandemic has played a bit of yo-yo with the yield curve since then; In late spring, investors expected long-term economic growth to stop sooner than expected, and then rise again towards the end of the summer in anticipation of the Fed’s announcement. a decrease in its stimulus aimed at long-maturity bonds. High inflation flattened the yield curve again at the end of September, and investors are now banking on rapid increases in short-term interest rates, pushing up short-term yields, and long-term bond yields have fallen. for fear of the economic impact of Omicron. .

While the yield curve has always been seen as the next best thing to do after a crystal ball for economic growth, some analysts now argue that the Fed’s bond purchases have distorted bond markets and affected the accuracy of the yield curve prediction.

With so much uncertainty, especially about the yield curve and market volatility lately, relying on active management can provide investors with confidence that their portfolios are aligned with current and future market expectations. Active management helps take a lot of the noise and stress out of investing, especially in bond markets that digest inflationary pressures, fears over Omicron’s impact, and a host of other components.

“One of the reasons many advisors look to the asset side when it comes to fixed income securities is that managing duration risk is not straightforward,” said Dave Nadig, director of research at ETF Trends. “The narrative changes almost daily based on economic data and reading the Fed’s tea leaves. Knowing there is a caring professional can often help investors sleep at night.”

T. Rowe Price Active Management Company believes in the difference and benefits of active investing and management. The company currently offers eight actively managed ETFs for investors looking for a variety of options, including the T. Rowe Price Ultra Short Term Bond ETF (TBUX) within bonds, an ETF that seeks to have a portfolio with an effective duration of 1.5 years or less. TBUX has an expense ratio of 0.17%.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



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